Foreclosure, Loan Modification And Short Sales

With unemployment rates remaining high and the  economy struggling to recover from the great  recession, many Americans are stuck in a daily  struggle to meet mortgage payments and keep their  homes. From 2006 to 2009, the US housing market witnessed a 30% decrease in real estate values and is expected to continue to drop by another 5% in the upcoming year.

Not only has this recession been the worst in recent memory, causing many individuals losing their jobs, but it has been compounded by unethical lending practices – resulting in you the homeowner coming up short when the mortgage payments are due. So what do you do when you can’t meet your mortgage? While foreclosure is considered the standard means for dealing with delinquent payments, you should be aware that other, better options may exist for you if you are one of the many dealing with financial struggles. We will briefly examine the process of foreclosure and why it should be avoided if possible before introducing two alternative options to foreclosure—loan modification and short sale.

Types of Foreclosure

Foreclosure is the process by which your lender (typically a bank) sells your home when you fail to meet payments. Money made from the sale of your home goes to pay off the lender, then to any additional parties owed money, and finally, if there is excess, to the evicted borrower. However, one should keep in mind that with the depressed housing market, it is very unlikely that the sale price of your house will exceed the amount of your debt—meaning you will be unlikely to receive any money.

Unlike the  alternatives to foreclosure, this method of removing your debt is forced by the lender and requires no agreement between you and your lending institution beyond the loan documentation you originally signed. Once you become delinquent on payments, or default on your loan, your lender has the legal basis to begin the process of foreclosure. This can either be carried out via judicial foreclosure or foreclosure by power of sale (also called a non-judicial foreclosure).

The primary distinction between these two types of foreclosure is that in a judicial foreclosure there will be a short court proceeding and the court will oversee the sale of your house. A non-judicial foreclosure, on the other hand, is where the property is sold directly by the mortgage holder without the oversight of the court. Because court is avoided, non-judicial foreclosures are usually much cheaper and faster processes for all parties involved. However, non-judicial foreclosure is only an option if your mortgage is really a “deed of trust.”

1. A notice of sale must be: 1) recorded in the county where the property is located at least fourteen (14) days prior to the sale; 2) mailed by certified, return receipt requested, to the borrower at least twenty (20) days before the sale; 3) posted on the property itself at least twenty (20) days before the sale; and 4) posted in one (1) public place in the county where the property is to be sold.
2. The notice of sale must contain the time and location of the foreclosure sale, as well as the property address, the trustee’s name, address and phone number and a statement that the property will be sold at auction.
3. The borrower has up until five days before the foreclosure sale to cure the default and stop the process.
4. The sale may be held on any business day between the hours of 9:00 am and 5:00 pm and must take place at the location specified in the notice of sale. The trustee may require proof of the bidder’s ability to pay their full bid amount. Anyone may bid at the sale, which must be in the form of a public auction with the property sold to the highest bidder. If necessary, the sale may be postponed by proper announcement at the time and location of the original foreclosure sale.

Aside from the emotional stress that can accompany the process of foreclosure, one of the biggest negative impacts is the result it will have on your credit . Record of foreclosure will make it harder for you to get loans in the future and will likely lead to higher interest rates demanded by banks as they will perceive loaning to you as more risky.

Can You Stop A  Foreclosure? Available  Defenses:Although most foreclosures in California are non-judicial, one must file a lawsuit in court providing evidence that the foreclosure is in some way illegal. Once a lawsuit is filed, the foreclosure proceedings are put on hold until the court can establish a ruling. As is the case with nearly every lawsuit, a good and experienced lawyer is essential as well as proper timing and raising of available defenses.   

The terms of the mortgage were unconscionable. This defense uses a branch of law called “equity” that judges issues of morality and fairness – since laws can’t always address such issues adequately. This strategy isn’t as simple as it sounds though, and claiming that the foreclosure isn’t fair won’t get you off the hook.Rather, one must utilize the justifications of previous lawsuits or other legal precedents, and subsequently relate your own lawsuit to a position that has been recognized by the courts in the past. After reviewing your documentation, an attorney can determine if this defense is appropriate.

A recent example of this defense occurred when a man who spoke very little English was pressured into signing a loan that he obviously would never be able to repay. In addition, the man wasn’t represented by an attorney during signing and was unaware of the penalties involved with defaulting. This man’s attorney argued, successfully, that the terms of the loan were unconscionable – meaning that both the terms of the loan were unjustifiable as well as the circumstances surrounding the situation.The attorney argued that the loan was blatantly unfair and predatory, thereby shocking “the conscience of the judge.”

The lender failed to follow state procedures. The foreclosure process is very clear-cut in California, making this defense either very easy or very difficult to prove. Simply put, there are some instances which the lender failed to follow the legal process of foreclosure, thus making the foreclosure illegal. Typically, the courts will not rule against the foreclosure, but rather make the lender restart the foreclosure process.

This defense takes some research and prior knowledge of statutes, which makes having legal counsel necessary.   As a general rule: a more serious the infraction on behalf of the lender begets a more serious the response from the court. The misspelling of a name won’t get you very far, but a failure to post a Notice of Default will be treated as a serious violation of foreclosure proceedings by the court. For example, if your lender began the foreclosure without providing a Notice of Default to either you or public records, or gave the notice but began the foreclosure the next week, the court may stop the foreclosure and force the lender to restart the process.

The lender can’t prove that they own the mortgage. This defense has proven evermore viable as the predatory practices of the lending industry have become more known. Let me explain. The recent mortgage scandal was caused in part to the slicing, dicing, repackaging, and sale of mortgages. What that means is that your lender may have sold the loan to someone else, who may have flipped the loan and sold it to yet another person. Why is this important? Only the legal owner of the loan has the right to initiate the foreclosure, and if your lender sold the loan then they cannot foreclose on your home. Make sure your lender is following the rules and request that they show you the original loan you signed. If they don’t have it, consult a lawyer. You might have a reasonable defense to halt the foreclosure proceedings – for good.

The lender engaged in unfair lending practices. You may be able to stop your foreclosure if you can prove that your lender violated federal or state law that are designed to protect consumers from predatory lending. Two federal laws are noteworthy, the Truth in Lending Act (TILA) and the Homeownership and Equity Protection Act (HOEPA). Lenders violate TILA when they fail to disclose information that’s legally mandated by this act. For example, a foreclosure may be stopped if your lender failed to provide the interest rate on the loan contract.

Other TILA requirements of the loan contract include the annual percentage rate, finance charges, the amount financed, the payment schedule, total payments, etc. A lawyer can review your documentation to ensure the lender followed TILA disclosure regulations. While TILA applies to all loans, HOEPA only applies to “high cost” loans that must meet the certain requirements – usually high interest rates or large up-front fees. HOEPA attempts to add transparency to “high cost” loans by stipulating timetables for notifications and by restricting certain mortgage terms, such as balloon payments, from being used in the loan contract. If the court determines that the terms of the loan or lender violated TILA or HOEPA, you (the borrower) have the right to retroactively rescind the loan. An attorney can provide specific details.

You’re a service member on active duty. If you’re in the military and on active duty, you have a right to delay the foreclosure proceedings and have special privileges enumerated in the Service members Civil Relief Act (SCRA). Namely, if you entered your loan agreement before starting active duty, then your foreclosure proceedings must take place in court even if your state customarily uses non-judicial foreclosures (e.g. California).

Additionally, if your foreclosure began while on active duty, you are automatically eligible for a 9-month postponement of foreclosure proceedings. You simply have to request the postponement from the court. Other Options Fortunately there are  alternate options that may be available to you if you are having difficulty meeting payments and are worried about a possible foreclosure. With either of these options, you avoid scarring your credit score with the record of a past foreclosure. However, both options require that you reach an agreement with your lending institution.

Short Sales

In a short sale, your bank agrees to allow you to sell your house for less than the amount you still owe on your loan.  Lenders may agree to short sales if they believe that letting you sell your house for an agreed upon price will result in losing less money overall than waiting for you to make payments or having to pay for the process of foreclosing upon your home themselves. The difficulty of achieving the negotiation of a short sale with your bank is, of course, that you need to have an offer on your home that meets the banks standards before you can really begin negotiating the possibility of the bank allowing the short sale. Moreover, you probably won’t be able to negotiate a short sale if you have multiple lenders, such as home equity lines of credit etc., because these secondary lenders are not likely to benefit from the sale. A short sale is an alternative to refinancing and similar to a voluntary foreclosure. In lieu of keeping your property, a short sale requires a real estate transaction in which a realtor sells the property to a buyer.

Although your lender sells the property for a loss, this process is still cheaper and more pleasant than a foreclosure. The primary difference between a short sale and refinancing, for you, is that keeping the property is not necessarily a priority. A major problem for short sales has been the inability of realtors to sell houses in the current market. Your lender may decide to foreclose instead, gaining ownership of the house in order to sell it later when prices are more favorable. Therefore, short sales are preferable if your house is both marketable and is currently worth a large part of what you owe to your lender.

What if you have more than one loan? If you have two or three mortgages on your home, a short sale will require approval of each lender. Unfortunately, when multiple loans exist a short sale is nearly impossible, as these other lenders have little financial gain. For tax purposes, the IRS sees a short sale as income. When you first got the loan, you didn’t have to pay taxes on it because you were obligated to repay the loan. However, because some of your debt was forgiven, this is seen as income on which you owe tax. If a short sale is a possibility for you, there are two important details that you should keep be aware of.

To begin with, the difference between the amount that you owed on your loan and the amount you pay the bank from the short sale will be treated as income and you will be taxed.  You can avoid being taxed on the deficiency amount if you can prove to the IRS that your total debt was greater than your total assets at the time of the short sale. This is referred to as being legally insolvent.

Finally, in negotiating with your lender to reach a short sale, be sure that agree to accept the offered sale price without seeking a deficiency judgment. If you do not make this stipulation clear, there is the possibility that the lender could go back on the agreement and sue you for the amount that you still owe. If this “deficiency judgment” were to take place, it would negatively affect your credit score.

Loan Modification If short selling is not an option for you or you want to attempt to keep your home, you may be able to figure out a more affordable payment schedule with your lender through the process of loan modification, which can either mean extending the term of your loan or reducing the amount of principal or interest that you must pay.  The ability to refinance will vary from lender to lender, but recent legislation, such as The Homeowner Affordability and Stability Plan, has made it easier for certain people to qualify for modification, especially if your loan is owned by Fannie Mae or Freddie Mac. Loan Modification is an attempt to change one or more of the terms of your mortgage because of an inability to meet current payments due to job loss, injury, variable interest rate reset, etc. The goal is to allow you to continue paying your mortgage but at a different interest rate, reduced monthly payment or a principal reduction of the loan.

Most people refinance or modify their loan to lower their monthly payments in order to free up some cash. This can be accomplished many different ways. If you are hopeful that your financial situation will improve in the future, modifying the structure of your payment schedule can be a way to reduce stress in the short run and work to keep your home.

For a comprehensive understanding of legal defenses against foreclosure, and other options, visit our Bankruptcy and Foreclosure section,  our Bankruptcy or Real Estate blogs,  and speak with Richard Korb. Richard  has over 30 years experience in real estate law, bankruptcy,  and has provided counsel against foreclosures. Feel free to call us for a free consultation at 510-524-0903. We have convenient offices in Berkeley-Oakland and Walnut Creek.